The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Monday, November 12, 2012

Will suicides be turning point in Spain's financial crisis?

Bloomberg reports that in response to the mortgage foreclosure related suicides Spain's government committed itself to "no family should lose their home as a result of the crisis."

With this commitment, we may have finally reached a turning point in Spain's financial crisis.

The logical way to implement this commitment is to require the banks to write down the mortgages to a level that the family can support based on its current income.

In the US, the rule of thumb for debt service payments, both principal and interest, that a family can support is no more than 33% of gross income. There is no reason this rule of thumb shouldn't work for Spain too.

Like Iceland, the intent of the write down is not to create "equity" for the borrowing family. It is to simply have the banks recognize upfront the losses that they would ultimately incur if the bank went through the long process of default and foreclosure. And do this without having the borrowing family lose its home.

What this means for the banks is the end of protecting bank book capital levels and banker bonuses. Absorbing the losses on the mortgages will essentially erase bank book capital throughout the Spanish banking system.

This is not a problem because modern banks like Spain's are designed to be able to continue operating and supporting the real economy with low or even negative book capital levels.

Banks can do this because of deposit insurance and access to central bank funding. Deposit insurance makes the Spanish taxpayers the banks' silent equity partner when they have low or negative book capital levels.

Prime Minister Mariano Rajoy said he will rush through measures to stem evictions in Spain after a woman committed suicide as officials tried to seize her home.

A bipartisan committee is meeting today to draw up plans to reduce evictions as Rajoy, who faces a general strike this week amid mounting protests, tries to control a growing sense of outrage at mortgage foreclosures.

Spain’s banking association responded today by announcing a two-year freeze on repossessions in cases of extreme need for “humanitarian reasons.”...

By definition this should apply to every borrower that is facing foreclosure. If the borrower had money, they would still be making their mortgage payments.

“No family should end up homeless as a result of the crisis,” Economy Minister Luis de Guindos told the European Parliament in Brussels today. “That is the commitment.”

A commitment that implies that the banks are going to have to recognize their losses. Iceland did this at the beginning of the financial crisis and their economy immediately recovered.

Rajoy has to respond to concern about rising eviction rates without inflicting further damage on a banking system crippled by bad debts following the collapse of a decade-long housing boom. Banks lent more than 600 billion euros ($763 billion) of mortgages that now have a default rate of 3.1 percent compared with 10.5 percent for lending as a whole, according to Bank of Spain data.

“There will be pressure to try to limit the number of mortgage evictions and iron out some of the inconsistencies in the legislation,” Daragh Quinn, a banking analyst at Nomura International Plc in Madrid, said in a phone interview today. “It could cause increased losses on mortgages for banks and reported rates of NPLs if it affects their ability to recover assets.”...

While the bankers would like to argue that Rajoy and the Spanish government are limited to actions that don't inflict damage on the banking system. This is a false argument.

Everyone knows that the banks lent 600 billion euros. Everyone knows that unemployment is over 25%. It does not take a rocket scientist to figure out that a sizable percentage of this mortgage related debt will never be repaid.

As a result, everyone knows that bank book capital levels are currently grossly overstated. More importantly, market participants already make an adjustment for this overstatement.

Forcing the banks to recognize the losses simply confirms what the market already knows about the Spanish banks.

Banks, set to benefit from a 100 billion-euro rescue package that Rajoy requested from the European Union in June, have become the focus of public outrage over foreclosures amid a growing public perception that they use abusive lending practices.

In a Metroscopia poll published yesterday, 91 percent of respondents said lenders exploit clients’ lack of legal knowledge to insert abusive clauses into mortgage contracts while 31 percent said some banks have acted in good faith.

“If we bail out the banks, how can we not bail out families?” Socialist Party No. 2 Elena Valenciano said in a Nov. 7 interview on Telecinco.....

The beauty of how the modern financial system is designed is that families can be bailed out without having to bail out the banks. The banks can be given time to rebuild their book capital levels through retention of 100% of pre-banker bonus earnings.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.